Downsizing Grocery Stores: A recipe for success?

Our November cover story, “Appetite for Risk,” tries to answer this fundamental question: How can traditional supermarket chains survive the onslaught of the big-box discounters and wholesalers, which keep eating their lunch?

Why are so few traditional grocers embracing the idea of building a smaller store prototype? “The grocers think it's generally a good idea, but they don't want to be the first ones to downsize. It can be costly,” says Green.

The pressure on supermarkets is occurring on multiple fronts. The increasing number of mixed-use projects nationally that feature specialty and gourmet food retailers such as Whole Foods contribute to the perception that the traditional grocery store format is tired. Today's mixed-use projects typically include high-end residential living that attracts sophisticated consumers. Additionally, office workers in a mixed-use project favor prepared meals to go.

Still, a dominant grocer like Publix that caters to a higher-end customer and delivers on promises of strong customer service can, and does, thrive. But if the supermarket anchor is No. 3 or No. 4 in terms of market share, that anchor is a candidate to go dark.

So, what's an investor to do? The best markets for shopping center investment, according to Green, follow population spikes from North Carolina to California including the Southeast, South Central and Southwest states. Picture a crescent moon from east to west. Understored urban areas also provide opportunities. But so much money is chasing real estate today that the best properties have already been taken, driving down cap rates in the process. Cap rates in Atlanta, for example, have fallen from 9.5% to 8% in recent years for grocery-anchored product.

Despite risks associated with necessity retail, real estate investors remain bullish. In our NREI survey, 36% of respondents who currently own grocery- and drug-anchored centers expect the price of properties to rise in 2006 (see chart).

“You really need to be thinking of the down side of these grocery-anchored properties more than you did before,” warns Brett Hutchens, CEO of Casto Lifestyle Properties in Sarasota, Fla., which pursues redevelopment opportunities. “We look at the underlying value of real estate because we can create value through redevelopment. A portfolio purchaser ought to have a different mindset.”